China Rate Increases in 2011 May Be Front-Loaded as Inflation Accelerates

By Bloomberg News -
Dec 27, 2010

China’s monetary tightening in 2011
may be mainly in the first half as officials tackle the fastest
inflation in more than two years, JPMorgan Chase & Co. and
Morgan Stanley said.

The People’s Bank of China increased key one-year lending
and deposit rates by 25 basis points on Christmas Day in its
second move since mid-October. The change took effect yesterday.
China’s stocks fell, erasing earlier gains, on speculation the
central bank will accelerate increases in interest rates. Bonds
dropped and yuan forwards climbed.

Premier Wen Jiabao’s government aims to limit asset bubbles
in the real-estate market and prevent rising prices from leading
to social unrest after flooding the economy with cash from late
2008 to drive a recovery. Officials may keep raising interest
rates and banks’ reserve requirements, sell bills to soak up
cash and allow more gains by the yuan against the dollar,
according to JPMorgan.

Chinese industrial companies’ profits rose 49.4 percent in
the 11 months through November from a year earlier, a report
showed today. That compared with a 7.8 percent gain in the same
period in 2009.

Rate Increases

The benchmark lending rate rose to 5.81 percent, compared
with 7.47 percent before cuts from late 2008 to counter the
global financial crisis. It will climb to 6.56 percent by the
end of next year, according to the median forecast in a
Bloomberg News survey of economists this month.

The deposit rate increased to 2.75 percent, compared with
the 5.1 percent annual pace of inflation in November.

China may raise rates as many as three times in the first
half of next year, according to Morgan Stanley, while JPMorgan
forecasts two increases in that period.

Officials have raised bank reserve ratios six times this
year and trimmed loan growth from record levels. They scrapped
the yuan’s almost two-year peg to the dollar in June as part of
winding down crisis policies. Since then, the currency has
gained about 3 percent.

The benchmark Shanghai Composite Index declined 1.9 percent
to 2,781.40 at close, the lowest since Oct. 8. Twelve-month non-
deliverable yuan forwards strengthened 0.4 percent to 6.4765 per
dollar as of 3:34 p.m. in Hong Kong, reflecting bets the
currency will strengthen 2.4 percent in one year, according to
data compiled by Bloomberg. The contracts touched 6.4740, the
highest level since Nov. 23.

Rising Yield

The yield on the 3.67 percent note due October 2020 climbed
nine basis points to 3.90 percent, according to the China
Interbank Bond Market.

Wen said yesterday that “inflation expectations are more
dire than inflation itself” and urged people to remain
confident, the state-run Xinhua News Agency reported. The
government can keep prices at a reasonable level through
measures such as boosting agricultural output, he said in a
radio broadcast, according to Xinhua.

A central bank survey this quarter showed consumers more
concerned about inflation than at any time in the past decade as
their savings lose value and companies such as McDonald’s Corp.
push up prices for everyday purchases.

Consumer prices rose 5.1 percent in November from a year
earlier, the most in 28 months, mainly driven by food costs.
Across 70 major cities, property prices climbed 7.7 percent.

‘Running Wild’

“All indications are that inflation expectations are
running wild in China,” Frederic Neumann, a Hong Kong-based
economist at HSBC Holdings Plc, said in an interview with
Bloomberg Television today. “The government will stamp up here
and try to dampen price pressures, particularly in the early
months of next year by tightening monetary policy and sending a
signal that they will not tolerate further price increases.”

China’s latest rate increase may precede a year in which
emerging-market central banks break away from their counterparts
in the industrial world by tightening monetary policy.

Morgan Stanley economists forecast a period of
“polarizing policy paths” as officials from China to Brazil
become increasingly confident that they can and should raise
rates because of robust growth and accelerating inflation. At
the same time, the Federal Reserve, the European Central Bank
and the Bank of Japan will leave their benchmarks on hold
throughout the year to bolster sluggish recoveries, they say.

The Morgan Stanley analysts predict 17 of 23 emerging
nations they monitor will lift rates in 2011 including Brazil,
China and India.

‘Center of Gravity’

The likely policy split illustrates how the economic
“center of gravity” is shifting toward emerging nations, said
David Cohen, an economist at Action Economics Ltd. in Singapore.

HSBC Holdings Plc economist Qu Hongbin said Dec. 25 that he
expects “more hikes in both interest rates and reserve ratios
in the coming months” in China.

In contrast, Fed policy makers this month renewed a pledge
for an “extended period” of low interest rates and affirmed a
plan to buy $600 billion of bonds through June, as part of
efforts to spur growth and reduce unemployment.

China is tightening after a record expansion of credit to
counter the effects of the world financial crisis. The broadest
measure of money supply, M2, has surged by 55 percent over the
past two years and outstanding yuan-denominated loans have
climbed 60 percent to 47.4 trillion yuan.

The nation needs “a slowdown in money and credit growth in
order to bring inflation fully under control,” Goldman Sachs
Group Inc. analysts Song Yu and Helen Qiao said in a note. “The
balancing act of keeping growth high and inflation low is
leaning increasingly towards the latter.”

China’s economy may expand 9.6 percent in 2011, the
International Monetary Fund estimated in October. That compared
with estimates that U.S. growth will be 2.3 percent and the euro
area expansion will be 1.5 percent.